Unclaimed property laws have been on the books for decades, but enforcement has been limited or nonexistent. Now states are focusing new attention on these languishing laws, bringing organizations of all sizes and types under higher scrutiny.

The Potential Risk of an Unclaimed Property Audit

6/6/2013

The Potential Risk of an Unclaimed Property Audit

Unclaimed property laws have been on the books in all 50 states for decades, but enforcement has been limited or nonexistent. Now, as states cast about for new sources of revenue, many are focusing new attention on these languishing laws, bringing organizations of all sizes and types under intense scrutiny. Those that are unprepared face substantial penalties, whether their noncompliance is intentional or not.

“Virtually every organization has an unclaimed property liability,” says Tim Reynolds, a tax partner with CliftonLarsonAllen. “It’s not until they are subjected to a costly and distracting state audit that they realize they have not been treating this liability properly.”

State-sponsored voluntary disclosure agreements (VDAs) are available, offering organizations an opportunity to bring themselves into compliance. They are also a chance to educate employees about unclaimed property laws and how to address them as a mandatory compliance issue in the future.

What is unclaimed property?

Simply stated, unclaimed property is property that has not been claimed by its rightful owner, and has been held by another party for a specified period of time. There are more than 100 different types of unclaimed property, but the most common are: uncashed payroll and accounts payable checks, abandoned savings and checking accounts, refunds due or credit balances owed to customers, unredeemed gift certificates and gift cards, abandoned utility or security deposits, escrow accounts, interest, and dividends.

Here’s a common example: An organization sends a final paycheck to an employee who is leaving employment, but for some reason, the check is never cashed. The employer tries unsuccessfully to locate the person so the check can be cashed. After a specified period, the check may be voided and the funds returned to revenue.

This is where organizations can run afoul of the law. If the property has not been claimed by its rightful owner after a specified period of time (this varies by state, but generally is one year or more), the holder of the property is obligated by law to remit the property to the appropriate state(s). The rationale for this surrendering of the property to the state is that the state can do an even more thorough job of tracking down the rightful owner. Property is held in trust by the state until it is claimed.

The scope of the unclaimed property issue shows why it is such a ripe target for cash-strapped states. According to the National Association of Unclaimed Property Administrators, more than $41.7 billion is waiting to be returned by state unclaimed property programs. In 2012, more than $2.25 billion was returned to owners through state programs.

If asked, many organizations would say that they don’t have an unclaimed property liability, or that unclaimed property compliance is voluntary. Still others believe that a lack of records would prevent an auditor from determining their liability, or that a liability only exists in states where the organization actively conducts business.

“These myths simply are not true,” Reynolds says. “Unclaimed property compliance is mandatory. Some organizations have historically treated unclaimed property as a source of revenue by ‘reversing’ payables, even though the law says this is not permitted. If these amounts are not being remitted to the appropriate state office, the organization is in violation of the law.”

Unclaimed property audits

A state audit can result in some serious sticker shock. The often-quoted case of CA, Inc. resulted in a $17.6 million payment for nearly 20 years of unpaid liability. The majority of states do not provide statute of limitations relief, and although the permitted “look-back” period varies by state, most allow audits to go back at least 10 years and sometimes more than 20 years.

Even an absence of records is no protection. Auditors are permitted to use standard statistical and mathematical tools, and models such as regression analysis, ratio analysis, and other techniques, to determine a liability amount. These estimation methods could result in large and sometimes grossly overstated assessments.

“Historically, some of these methods have been questionable, and in some cases, inappropriate for the type of organization or industry that is being audited,” Reynolds says. Nevertheless, they are still employed by contract auditors that are typically hired by the state and compensated on a contingency fee basis — a built-in incentive to generate the largest estimated assessments.

Once the liability has been established, interest and penalties may be assessed. These vary by state, but interest typically ranges from 5 percent to 25 percent, and penalties can be anywhere from 10 percent to 50 percent. In fact, it is not uncommon for interest and penalties to exceed the liability assessment due to the number of years covered by the audit. In some rare instances, civil and criminal penalties are available if noncompliance is proven to be willful.

Initiating a compliance plan

Depending on the nature of the organization, noncompliance or improper compliance with unclaimed property laws can present significant risk. Initiating an unclaimed property compliance plan to reduce the risk might include these best practices:

Determine potential exposure — Consider conducting an internal audit of the organization’s policy and compliance history (if any) and quantifying any current risk exposure.

Get into compliance with all applicable states — Many states now have voluntary disclosure agreements (VDAs) or amnesty programs. These programs may waive penalties and limit the look-back period to a reduced number of years.

Establish a compliance officer or committee — Appoint a responsible group or designate an individual to oversee compliance and administration of unclaimed property protocols. Unless a group or individual is clearly responsible for this function, compliance may continue to fall through the cracks.

Educate and communicate — Initiate a plan to educate administrators, staff, representatives, and agents about what unclaimed property is, how to handle it, how to report it, and the potential impact it could have on the organization.

How we can help

Unclaimed property laws are complex and create significant challenges to an organization’s financial and nonfinancial resources. CliftonLarsonAllen can help organizations determine their potential exposure to unclaimed property risk and implement policies, procedures, and internal controls to reduce the risk. Proactive organizations can get assistance in applying for VDA and amnesty programs. Organizations under audit can also call on CLA for experienced audit defense.

CliftonLarsonAllen is a member firm of the “Nexia International” network. Nexia International Limited does not deliver services in its own name or otherwise. Nexia International Limited does not accept any responsibility for the commission of any act, or omission to act by, or the liabilities of, any of its members. Each member firm within the Nexia International network is a separate legal entity.